UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                              --------------------

                                   FORM 10-QSB

(Mark One)

|X|   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

            For the quarterly period ended June 30, 2001

|_|   TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

            For the transition period from ___________ to ___________


                         Commission File Number 0-23971

                          GASTON FEDERAL BANCORP, INC.
                          ----------------------------
             (Exact name of registrant as specified in its charter)

        United States                                           56-2063438
-------------------------------                           ----------------------
(State or other jurisdiction of                             (I.R.S. Employer
 incorporation or organization)                           Identification Number)

            245 West Main Avenue, Gastonia, North Carolina 28052-4140
            ---------------------------------------------------------
                    (Address of principal executive offices)

       Registrant's telephone number, including area code: (704)-868-5200
                                                           --------------


--------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report

      Indicate by check |X| whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

      Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: There were 4,209,434 shares
of the Registrant's common stock outstanding as of August 7, 2001.
<PAGE>

GASTON FEDERAL BANCORP, INC.

                                      INDEX

                                                                            Page
                                                                            ----

PART I.  FINANCIAL INFORMATION

         Item 1.   Consolidated Financial Statements......................   2

              Consolidated Statements of Financial Condition as of
                    June 30, 2001 and December 31, 2000 ..................   2

              Consolidated Statements of Operations for the three and six
                  months ended June 30, 2001 and 2000.....................   3

              Consolidated Statements of Comprehensive Income for the
                  six months ended June 30, 2001 and 2000.................   4

              Consolidated Statements of Cash Flows for the six months
                  ended June 30, 2001 and 2000............................   5

              Notes to Consolidated Financial Statements..................   6

         Item 2.  Management's Discussion and Analysis of Financial
                  Condition and Results of Operations.....................   8

PART II. OTHER INFORMATION................................................  11


                                       1
<PAGE>

PART I. FINANCIAL INFORMATION

      ITEM 1. Consolidated Financial Statements

Gaston Federal Bancorp, Inc. and Subsidiary
Consolidated Statements of Financial Condition
(in thousands)

<TABLE>
<CAPTION>
                                                                    June 30,    December 31,
                                                                      2001         2000
                                                                    --------     --------
                                                                   (unaudited)
<S>                                                                 <C>          <C>
Assets
Cash and cash equivalents .......................................     24,521       26,709
Investment securities available-for-sale, at fair value .........     33,818       32,822
Mortgage-backed securities available-for-sale, at fair value ....     27,171       22,955
Loans, net ......................................................    165,754      158,820
Premises and equipment, net .....................................      4,851        4,163
Accrued interest receivable .....................................      1,287        1,352
Federal Home Loan Bank stock ....................................      2,177        2,177
Other assets ....................................................      6,275        3,752
                                                                    --------     --------
   Total assets .................................................   $265,854     $252,750
                                                                    ========     ========

Liabilities and Equity
Deposits ........................................................   $180,108     $167,931
Advances from borrowers for taxes and insurance .................        805          351
Borrowed money ..................................................     42,105       42,737
Other liabilities ...............................................      1,850        1,968
                                                                    --------     --------
   Total liabilities ............................................    224,868      212,987

Retained earnings, substantially restricted .....................     24,686       23,931
Common stock and additional paid in capital, net of ESOP loan ...     15,183       15,241
Unrealized gain on securities available-for-sale, net of tax ....      1,117          591
                                                                    --------     --------
   Total equity .................................................     40,986       39,763
                                                                    --------     --------

Total liabilities and equity ....................................   $265,854     $252,750
                                                                    ========     ========
</TABLE>

See accompanying notes to consolidated financial statements.


                                       2
<PAGE>

Gaston Federal Bancorp, Inc. and Subsidiary
Consolidated Statements of Operations (unaudited)
(in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                Three Months               Six Months
                                                               Ended June  30,           Ended June 30,
                                                           -----------------------   -----------------------
                                                              2001         2000         2001         2000
                                                           ----------   ----------   ----------   ----------
<S>                                                        <C>          <C>          <C>          <C>
Interest income
Loans ..................................................   $    3,149   $    3,306   $    6,302   $    6,467
Investment securities ..................................          490          424          965          844
Interest-bearing deposits ..............................          217          166          556          204
Mortgage-backed and related securities .................          396          275          764          672
                                                           ----------   ----------   ----------   ----------
  Total interest income ................................        4,252        4,171        8,587        8,187

Interest Expense
Deposits ...............................................        2,043        1,766        4,090        3,435
Borrowed funds .........................................          598          619        1,221        1,174
                                                           ----------   ----------   ----------   ----------
Total interest expense .................................        2,641        2,385        5,311        4,609
                                                           ----------   ----------   ----------   ----------

Net interest income ....................................        1,611        1,786        3,276        3,578

Provision for loan losses ..............................           30            8           60           15
                                                           ----------   ----------   ----------   ----------

  Net interest income after provision for loan losses ..        1,581        1,778        3,216        3,563

Noninterest Income
Service charges on deposit accounts ....................          475          150          843          285
Gain on sale of assets .................................            0          227            0          227
Other income ...........................................          323          377          573          644
                                                           ----------   ----------   ----------   ----------
  Total noninterest income .............................          798          754        1,416        1,156

Noninterest Expense
Compensation and benefits ..............................          938          995        1,770        1,897
Occupancy and equipment expense ........................          171          152          331          318
Loss on sale of assets .................................            0            1            9            1
Other expenses .........................................          531          427        1,041          890
                                                           ----------   ----------   ----------   ----------
  Total noninterest expense ............................        1,640        1,575        3,151        3,106

Income before income taxes .............................          739          957        1,481        1,613

Provision for income taxes .............................          229          338          459          536
                                                           ----------   ----------   ----------   ----------

Net income .............................................   $      510   $      619   $    1,022   $    1,077
                                                           ==========   ==========   ==========   ==========

Basic earnings per share ...............................   $     0.13   $     0.15   $     0.25   $     0.26
Diluted earnings per share .............................   $     0.13   $     0.15   $     0.25   $     0.26

Basic weighted average outstanding shares ..............    4,074,992    4,086,254    4,078,814    4,108,661
Diluted weighted average outstanding shares ............    4,078,059    4,086,254    4,080,348    4,108,661

Dividends paid per share ...............................   $    0.075   $    0.060   $    0.150   $    0.120
</TABLE>


                                       3
<PAGE>

Gaston Federal Bancorp, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income (unaudited)
(in thousands)

<TABLE>
<CAPTION>
                                                                         Six Months Ended
                                                                             June 30,
                                                                        -----------------
                                                                          2001      2000
                                                                        -------   -------
<S>                                                                     <C>       <C>
Net income ..........................................................   $ 1,022   $ 1,077
Other comprehensive income, net of tax:
    Unrealized gains on securities:
        Unrealized holding gains/(losses) arising during  period ....       520       (73)
        Reclassification adjustment for losses included in net income         6      (145)
                                                                        -------   -------
    Other comprehensive income ......................................       526      (218)
                                                                        -------   -------

Comprehensive income ................................................   $ 1,548   $   859
                                                                        -------   -------
</TABLE>


                                       4
<PAGE>

Gaston Federal Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows (unaudited)
(in thousands)

<TABLE>
<CAPTION>
                                                                                           Six Months Ended
                                                                                               June 30,
                                                                                         --------------------
                                                                                           2001        2000
                                                                                         --------    --------
<S>                                                                                      <C>         <C>
Cash flows from operating activities:
  Net income .........................................................................   $  1,022    $  1,077
  Adjustments to reconcile net income to net cash provided by operating activities:
      Provision for loan losses ......................................................         60          15
      Depreciation ...................................................................        199         160
      Purchase of bank-owned life insurance ..........................................     (2,578)     (2,097)
      (Gain) on sale of investment securities ........................................          0        (227)
      Loss on sale of mortgage backed securities .....................................          9           0
      Loss on sale of OREO ...........................................................          0           1
      (Increase) decrease in other assets ............................................        130         (68)
      Increase (decrease) in other liabilities .......................................       (118)       (120)
                                                                                         --------    --------

        Net cash provided by operating activities ....................................     (1,276)     (1,259)
                                                                                         --------    --------

Cash flows from investing activities:
  Net (increase) in loans receivable .................................................     (6,948)     (7,237)
  Sale of investment securities ......................................................          0       2,050
  Sale of mortgage-backed securities .................................................      1,243         614
  Sale of premises and equipment .....................................................        196           0
  Sale of real estate owned ..........................................................          0         247
  Maturities and prepayments of investment securities ................................      3,930       1,080
  Maturities and prepayments of mortgage-backed securities ...........................      3,597       1,693
  Purchases of investments ...........................................................     (4,400)     (4,600)
  Purchases of mortgage-backed securities ............................................     (9,066)     (4,149)
  Purchases of FHLB stock ............................................................          0        (402)
  Net cash flows from other investing activities .....................................     (1,082)     (1,372)
                                                                                         --------    --------

        Net cash (used for) investment activities ....................................    (12,530)    (12,076)
                                                                                         --------    --------

Cash flows from financing activities:
  Net increase in deposits ...........................................................     12,177       2,218
  Dividends to stockholders ..........................................................       (267)       (512)
  Repurchase of common stock .........................................................       (115)       (897)
  Net increase (decrease) in borrowed money ..........................................       (631)      7,550
  Increase in advances from borrowers for insurance and taxes ........................        454         593
                                                                                         --------    --------

        Net cash provided by financing activities ....................................     11,618       8,952
                                                                                         --------    --------

Net (decrease) in cash and cash equivalents ..........................................     (2,188)     (4,383)

Cash and cash equivalents at beginning of period .....................................     26,709       7,197
                                                                                         --------    --------

Cash and cash equivalents at end of period ...........................................   $ 24,521    $  2,814
                                                                                         ========    ========
</TABLE>


                                       5
<PAGE>

                   GASTON FEDERAL BANCORP, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note A - Basis of Presentation

      In management's opinion, the financial information, which is unaudited,
reflects all adjustments (consisting solely of normal recurring adjustments)
necessary for a fair presentation of the financial information as of and for the
three and six month periods ended June 30, 2001 and 2000, in conformity with
generally accepted accounting principles. The financial statements include the
accounts of Gaston Federal Bancorp, Inc. (the "Company") and its wholly-owned
subsidiary, Gaston Federal Bank (the "Bank"). Operating results for the three
and month periods ended June 30, 2001, are not necessarily indicative of the
results that may be expected for future periods.

      The organization and business of the Company, accounting policies
followed, and other information are contained in the notes to the consolidated
financial statements of the Company as of and for the years ended September 30,
2000 and 1999, filed as part of the Company's annual report on Form 10-KSB.
These consolidated financial statements should be read in conjunction with the
annual consolidated financial statements.

      During the quarter ended December 31, 2000, the Company's Board of
Directors adopted a resolution to change the Company's fiscal year end from
September 30th to December 31st, effective October 1, 2000. The Company filed a
Form 8-K providing public notice of the change in the Company's fiscal year. All
prior period financial information is presented for comparable periods of the
preceding calendar year.

Note B - Earnings per Share

      Earnings per share has been determined under the provisions of the
Statement of Financial Accounting Standards No. 128, Earnings Per Share. For the
quarters ended June 30, 2001 and 2000, basic earnings per share has been
computed based upon the weighted average common shares outstanding of 4,074,992
and 4,086,254, respectively. For the six months ended June 30, 2001 and 2000,
basic earnings per share has been computed based upon the weighted average
common shares outstanding of 4,078,814 and 4,108,661, respectively.

      The only potential stock of the Company as defined in the Statement of
Financial Accounting Standards No. 128, Earnings Per Share, is stock options
granted to various directors and officers of the Bank. The following is a
summary of the diluted earnings per share calculation for the three and six
months ended June 30, 2001, and 2000: (in thousands, except share data)

<TABLE>
<CAPTION>
                                              Three Months              Six Months
                                             Ended June 30,           Ended June 30,
                                        -----------------------   -----------------------
                                            2001         2000         2001         2000
                                        ----------   ----------   ----------   ----------
<S>                                     <C>          <C>          <C>          <C>
Net income ..........................   $      510   $      619   $    1,022   $    1,077

Weighted average outstanding shares .    4,074,992    4,086,254    4,078,814    4,108,661
Dilutive effect of stock options ....        3,067            0        1,534            0
                                        ----------   ----------   ----------   ----------

Weighted average diluted shares .....    4,078,059    4,086,254    4,080,348    4,108,661

Diluted  earnings per share .........   $     0.13   $     0.15   $     0.25   $     0.26
</TABLE>


                                       6
<PAGE>

Options were excluded from the calculation of diluted earnings per share for the
three and six month periods ended June 30, 2000, because the exercise prices of
$12.00 for 192,569 shares and $13.00 for 10,000 shares exceeded the average
market price of $10.87 for the quarter and $11.15 for the six month period.

Note C - Stock Compensation Plans

      On April 12, 1999, the Company's shareholders approved the Gaston Federal
Bank 1999 Stock Option Plan that provided for the issuance of 211,335 options
for directors and officers to purchase the Company's common stock. As of June
30, 2001, 191,748 options had been awarded under the plan at a weighted average
exercise price of $12.05 and a weighted average contractual life of 94 months.
There were 134,449 options fully vested as of June 30, 2001. The Company applies
the provisions of Accounting Principles Board Opinion No. 25 in accounting for
the Stock Option Plan described above and, accordingly, no compensation expense
has been recognized in connection with the granting of the stock options.

Note D - Impact of Recently Adopted Accounting Standards

      SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, issued in June 1998, as amended by SFAS No. 137 and SFAS No. 138,
establishes accounting and reporting requirements for derivative instruments,
including derivative instruments embedded in other contracts. The Company
adopted the provisions of this statement effective October 1, 2000. In
connection with the adoption of the provisions of SFAS No. 133, the Company
transferred all securities previously designated as held-to-maturity at
September 30, 2000, into the available-for-sale category. The transfer was
accounted for at the fair values of the securities at September 30, 2000. The
effect of the transfer was to decrease carrying values of these securities by
approximately $603,000 and increase deferred tax assets by approximately
$236,000.


                                       7
<PAGE>

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
        of Operations

      From time to time, the Company may publish forward-looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments, new products, and similar matters. The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements provided that the Company notes that a variety of
factors could cause the Company's actual results to differ materially from the
anticipated results expressed in the Company's forward-looking statements. The
risks and uncertainties that may affect the operations, performance, and results
of the Company's business include, but are not limited to, changes in economic
conditions, changes in interest rates, and changes in laws and regulations.
Accordingly, past results and trends should not be used by investors to
anticipate future results or trends. Statements included in this report should
be read in conjunction with the Company's Annual Report on Form 10-KSB and are
incorporated into this discussion by this reference.

Comparison of Financial Condition

      Assets. Total assets of the Company increased by $13.1 million, or 4.9%,
from $252.8 million as of December 31, 2000, to $265.9 million as of June 30,
2001. During the six month period ended June 30, 2001, mortgage loans decreased
by $6.6 million, or 5.9%, to $104.6 million, while nonmortgage loans increased
by $14.2 million, or 31.0%, to $60.1 million. This shift in the loan portfolio
composition reflects management's efforts to make the Company's balance sheet
more reflective of a community bank. Management plans to continue to grow the
loan portfolio in a safe and sound manner with an emphasis on the origination
and retention of short-term, high-yielding nonmortgage loans and the origination
and sale of mortgage loans. Also during the period, cash and cash equivalents
decreased $2.2 million to $24.5 million, investment securities increased by
$996,000 to $33.8 million, and mortgage-backed securities increased by $4.2
million to $27.2 million. The increases in investment securities and
mortgage-backed securities were funded by increases in deposits. The decrease in
cash and cash equivalents was primarily due to the repayment of $2.0 million in
borrowed money.

      Liabilities. Total liabilities increased by $11.9 million, or 5.3%, from
$213.0 million as of December 31, 2000, to $224.9 million as of June 30, 2001.
The primary reason for the change was a $12.2 million, or 6.8%, increase in
total deposits from $167.9 million to $180.1 million. Deposits increased due to
competitive interest rates, aggressive marketing, and employee incentives. All
deposit growth came from the Bank's primary market area. Management plans to
continue in its efforts to gain deposit market share through new product
development and branch expansion with an emphasis on demand deposits. Borrowed
money decreased by $631,000, or 1.5%, to $42.1 million. Borrowed money is
primarily comprised of various callable and fixed-term Federal Home Loan Bank
advances with a weighted average interest rate of 5.8%.

      Equity. Total equity increased by $1.2 million, or 3.0%, from $39.8
million as of December 31, 2000, to $41.0 million as of June 30, 2001. This
increase was primarily due to the $1.0 million in earnings during the period and
a $526,000 increase in unrealized gains on available-for-sale securities. Also
during the period, the Company paid $267,000 in cash dividends and repurchased
9,500 shares of common stock at a cost of $115,000, or $12.16 per share. The
Company has been authorized to repurchase a total of 581,797 shares of common
stock, or 136,335 additional shares, as of June 30, 2001. Management will
continue to repurchase common stock of the Company at prices that are considered
to be attractive.


                                       8
<PAGE>

Comparison of Results of Operations for the Three Months Ended June 30, 2001 and
2000

      General. Net income for the Company for the three months ended June 30,
2001, amounted to $510,000, or $0.13 per share, as compared to $619,000, or
$0.15 per share, for the three months ended June 30, 2000. Net income for the
quarter ended June 30, 2000, included a $226,000 nonrecurring net gain on sale
of assets, resulting in net operating income of $481,000, or $0.12 for the
quarter.

      Net interest income. Net interest income decreased by $174,000, or 9.8%,
to $1.6 million for the three months ended June 30, 2001. Interest income
increased by $81,000, primarily due to a $16.8 million increase in interest
earning assets to $241.8 million. This increase was offset, in part, by a 57
basis point decrease in the yield on interest earning assets to 6.83%. The Bank
continues to maintain a large balance of low-yielding interest earnings bank
deposits resulting from the proceeds of the sale of $18.2 million in fixed rate
mortgage loans during the quarter ended December 31, 2000. A large portion of
these proceeds will be used for the acquisition of all of the common stock of
Innes Street Financial Corp. This transaction, which is subject to shareholder
and regulatory approval, is expected to cost $37.4 million and should be
completed by the fourth quarter of 2001. Interest expense increased by $256,000,
primarily due to a $19.3 million increase in total deposits to $180.1 million.

      Provision for loan losses. The provision for loan losses amounted to
$30,000 for the three months ended June 30, 2001, as compared to $7,500 for the
three months ended June 30, 2000. This represents an increase of $22,500. The
amount of the provision for loan losses was increased, in part, due to the
increased emphasis on the origination and retention of higher-yielding
commercial and consumer loans. These loans possess a higher level of risk than
owner-occupied mortgage loans and require a higher level of reserves. The ratio
of loan loss reserves to gross loans was 0.91% as of June 30, 2001, and 0.86% as
of June 30, 2000.

      Noninterest income. Noninterest income, net of nonrecurring gains on sales
of assets, amounted to $798,000 for the three months ended June 30, 2001, as
compared to $528,000 for the three months ended June 30, 2000. This increase of
$270,000, or 51.1%, was primarily due to increased fees generated by the Bank's
mortgage-banking department and additional fee income derived from deposit
products. Management plans to continue in its efforts to increase its
outstanding balance of fee-generating demand deposit accounts through targeted
advertising and branch expansion. Total demand deposit accounts increased by
23.9% during the past 12 months to $25.2 million as of June 30, 2001. During the
quarter ended June 30, 2000, the Company recognized a nonrecurring gain of
$227,000 from the sale of $2.7 million in investment and mortgage-backed
securities.

      Noninterest expense. Noninterest expense increased by $65,000, or 4.1%, to
$1.6 million as of June 30, 2001. This increase was primarily due to higher
occupancy and equipment associated with the opening of the Bank's sixth
full-service office in February 2001, and increased expenses associated with
servicing the Bank's growing demand deposit account portfolio. This was increase
offset, in part, by lower compensation expense, data processing expense, and
advertising expense.

      Income taxes. Income taxes amounted to $229,000, or 31.0% of taxable
income, for the quarter ended June 30, 2001, as compared to $338,000, or 35.3%
of taxable income, for the quarter ended June 30, 2000. The decrease in the
effective tax rate was primarily due to the increased income received from
tax-advantaged assets such as Federal Home Loan Bank deposits and Bank-Owned
Life Insurance ("BOLI").


                                       9
<PAGE>

Comparison of Results of Operations for the Six Months Ended June 30, 2001 and
2000

      General. Net income for the Company for the six months ended June 30,
2001, amounted to $1,022,000, or $0.25 per share, as compared to $1,077,000, or
$0.26 per share, for the six months ended June 30, 2000. Net income for the six
months ended June 30, 2000, included a $226,000 nonrecurring net gain on sale of
assets, resulting in net operating income of $939,000, or $0.23, for the period.

      Net interest income. Net interest income decreased by $302,000, or 8.4%,
to $3.3 million for the six months ended June 30, 2001. Interest income
increased by $399,000, primarily due to a $16.8 million increase in interest
earning assets to $241.8 million. This increase was offset, in part, by a 57
basis point decrease in the yield on interest earning assets to 6.83%. The Bank
continues to maintain a large balance of low-yielding interest earnings bank
deposits resulting from the proceeds of the sale of $18.2 million in fixed rate
mortgage loans during the quarter ended December 31, 2000. A large portion of
these proceeds will be used for the acquisition of all of the common stock of
Innes Street Financial Corp. This transaction, which is subject to shareholder
and regulatory approval, is expected to cost $37.4 million and should be
completed by the fourth quarter of 2001. Interest expense increased by $702,000,
primarily due to a $19.3 million increase in total deposits to $180.1 million.

      Provision for loan losses. The provision for loan losses amounted to
$60,000 for the six months ended June 30, 2001, as compared to $15,000 for the
six months ended June 30, 2000. This represents an increase of $45,000. The
amount of the provision for loan losses was increased, in part, due to the
increased emphasis on the origination and retention of higher-yielding
commercial and consumer loans. These loans possess a higher level of risk than
owner-occupied mortgage loans and require a higher level of reserves. The ratio
of loan loss reserves to gross loans was 0.91% as of June 30, 2001, and 0.86% as
of June 30, 2000.

      Noninterest income. Noninterest income, net of nonrecurring gains on sales
of assets, amounted to $1.4 million for the six months ended June 30, 2001, as
compared to $929,000 for the six months ended June 30, 2000. This increase of
$487,000, or 52.4%, was primarily due to increased fees generated by the Bank's
mortgage-banking department and additional fee income derived from deposit
products. Management plans to continue in its efforts to increase its
outstanding balance of fee-generating demand deposit accounts through targeted
advertising and branch expansion. Outstanding demand deposit accounts increased
by 23.9% during the past 12 months to $25.2 million as of June 30, 2001. During
the six months ended June 30, 2000, the Company recognized a nonrecurring gain
of $227,000 from the sale of $2.7 million in investment and mortgage-backed
securities.

      Noninterest expense. Noninterest expense increased by $45,000, or 1.2%, to
$3.1 million as of June 30, 2001. This increase was primarily due to higher
occupancy and equipment associated with the opening of the Bank's sixth
full-service office in February 2001, and increased expenses associated with
servicing the Bank's growing demand deposit account portfolio. This was increase
offset, in part, by lower compensation expense, data processing expense, and
advertising expense.

      Income taxes. Income taxes amounted to $459,000, or 31.0% of taxable
income, for the six month period ended June 30, 2001, as compared to $536,000,
or 33.2% of taxable income, for the six month period ended June 30, 2000. The
decrease in the effective tax rate was primarily due to the increased income
received from tax-advantaged assets such as Federal Home Loan Bank deposits and
Bank-Owned Life Insurance ("BOLI").


                                       10
<PAGE>

Liquidity and Capital Resources

      The objective of the Bank's liquidity management is to ensure the
availability of sufficient cash flows to meet all financial commitments and to
capitalize on opportunities for expansion. Liquidity management addresses the
Bank's ability to meet deposit withdrawals on demand or at contractual maturity,
to repay borrowings as they mature, and to fund new loans and investments as
opportunities arise.

      The Bank's primary sources of internally generated funds are principal and
interest payments on loans receivable and cash flows generated from operations.
External sources of funds include increases in deposits and advances from the
Federal Home Loan Bank of Atlanta.

      The Bank is subject to various regulatory capital requirements
administered by the banking regulatory agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly discretionary actions
by the regulators that, if undertaken, could have a direct material effect on
the Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classifications are subject
to qualitative judgments by the regulators about components, risk-weightings,
and other factors. As of June 30, 2001, Gaston Federal Bank's level of capital
substantially exceeded all applicable regulatory requirements.


                                       11
<PAGE>

PART II. OTHER INFORMATION

Legal Proceedings

      There are various claims and lawsuits in which the Bank is periodically
involved incidental to the Bank's business. In the opinion of management, no
material loss is expected from any of such pending claims or lawsuits.

Changes in Securities

      Not applicable.

Defaults Upon Senior Securities

      Not applicable.

Submission of Matters to a Vote of Security Holders

      There were no meetings of the Company's shareholders during the quarter
ended June 30, 2001.

Exhibits and Report on Form 8-K.

      On July 25, 2001, Gaston Federal Bancorp, Inc. ("the Company") filed a
Form 8-K to provide public notice that on July 16, 2001, the Company entered
into an Agreement and Plan of Merger with Innes Street Financial Corporation
("Innes Street"). Innes Street is the holding company for Citizens Bank, Inc., a
savings bank headquartered in Salisbury, North Carolina, which operates three
full-service offices in Salisbury, Statesville, and Rockwell, North Carolina. As
of March 31, 2001, Citizens Bank had total assets of $212.2 million, total
deposits of $168.6 million, and stockholders' equity of $26.5 million. Under the
terms of the agreement, the Company will pay $18.50 per share in cash for each
of the 1,974,325 outstanding shares of Innes Street's common stock. This
represents 138% of Innes Street's tangible book value per share as of March 31,
2001, and 28.5 times Innes Street's earnings per share for the 12 months ended
March 31, 2001. Innes Street will be merged into a subsidiary of the Company and
all shares of Innes Street will be cancelled. The aggregate purchase price is
approximately $38 million. Upon completion of the transaction, the Company will
have approximately $470 million in assets and will have a total of nine offices
in the southern piedmont region of North Carolina. Management estimates that the
cost savings opportunities between the two companies equals 38% of Innes
Street's annualized operating income, or $1.7 million pretax. As a result of the
anticipated cost savings, management believes that the transaction will be
immediately accretive to earnings. Consummation of the merger is subject to
approval by Innes Street's shareholders and the receipt of all required
regulatory approvals. It is anticipated that the transaction will be completed
in the fourth quarter of 2001.


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<PAGE>

SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.

                                GASTON FEDERAL BANCORP, INC.


Date: August 13, 2001           By:  /s/ Kim S. Price
                                     ------------------------------------
                                     Kim S. Price
                                     President and Chief Executive Officer


Date: August 13, 2001           By: /s/ Gary F. Hoskins
                                    -------------------------------------
                                    Gary F. Hoskins
                                    Senior Vice President, Chief Financial
                                    Officer and Treasurer


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